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Thursday, 10 September 2015

Has an entire generation been ill-advised on Financial Planning? (Part 1)

Whole life insurance is a financial product which many of us own or are recommended by banks and financial planners. Recently, I came across a 15 year premium whole life product with
a sum assured of $100,000. Its annual premium is in the region of $2,155. It got me
thinking: Are there ways to obtain better returns, at lower risk but with the
same amount of sum assured?

Jerome (age 27) decides to create his own product which replicates a similar 15 year premium whole life. To replicate the components of whole life, he does the following:

Term Insurance

Jerome buys the AVIVA NS Term which covers him for a sum
assured of $100,000. The plan costs $153.60 per year (for public servants, you
can use the POGIS which costs $60 per year for every $100,000 of sum assured).

Investment component

As mentioned, most insurance consist of an investment
component where majority of funds are allocated for investments in different
asset classes- bonds, stocks etc. This is to generate the projected returns.

Jerome mirrors this and creates a portfolio with two asset
classes, bond and equities. He will put $800 in the STI ETF and $1200
into “CPF bonds”, to form 40% equity and 60% bond portfolio. To buy these
“CPF bonds” for his bond component, Jerome does an annual voluntary contribution
to his CPF SA. As the “CPF Bond” is backed by the Singapore government, his bond component is triple A rated of very low risk. The returns of
these "CPF bonds" are guaranteed ( 4%/ 5% for the first $60,000 combined).

With only 40% of portfolio subjected to market risk, Jerome’s
portfolio is far less risky than any insurance’s. You can read here about voluntary contribution to the CPF SA.

Total Premiums paid

The annual premium Jerome pays for his own DIY is $2,153.60

Premiums paid

It is worth noting, Jerome still has to pay premiums of his
Aviva NS term insurance from the age of 42 to 65 unlike for a 15 year premium whole life. In my analysis, Jerome’s premiums are covered
during this period for the following 2 reasons. Firstly, the NS Aviva term
provides returns during good years (about 1-2 month premium is returned). Hence
during good year, Jerome receives 1-2 month rebates which he invests into the SPDR STI ETF. Since inception in April 2002, this ETF has generated an annualised return of approximately 7.11%
as of end August 2015. This includes the market rout witnessed during the past
two months.

Secondly, as Jerome had been topping up $1,200 yearly into
his CPF SA, he received a tax savings of $84 annually. Similarly, he invests
the tax saving proceeds into a STI ETF (annualised 7.11% returns) and then start
depleting it from age 42 to 65, hence covering his premiums. In fact, Jerome
still has $2,352 leftover from this method after paying the premiums until 65.

So it seems our very own DIY product is viable and less
risky. In my next post, I will explain how this plan generates a higher
projected return.